Failure to Pay Arbitration Fees on Time Did Not Breach Arbitration Agreement

Takeaway: A provision of California law providing that when an employer fails to pay arbitration fees on time, the employee may bypass arbitration and proceed directly to court is pre-empted by the Federal Arbitration Act.

An employer that failed to pay arbitration fees within 30 days of the due date did not breach an arbitration agreement stating that it was governed by the Federal Arbitration Act (FAA) and not expressly adopting California arbitration laws, a California appeals court ruled.

Section 1281.97 of the California Code of Civil Procedure—which provides that if an employer does not pay required arbitration fees within 30 days after the due date, it breaches the agreement and waives its right to compel arbitration—did not apply in these circumstances, the court said.

The employee worked for the employer from February 2015 to August 2020. The arbitration agreement she had executed said that it was governed by the FAA and that the Federal Rules of Civil Procedure would apply in arbitration proceedings. On July 16, 2021, the employee filed a complaint against the employer for disability discrimination, Labor Code violations and related causes of action. On Nov. 8, 2021, the parties agreed to stay the trial court proceedings and arbitrate pursuant to their agreement.

The employee filed a demand for arbitration with the Judicial Arbitration and Mediation Services, Inc. (JAMS). On April 7, 2022, JAMS sent a notice to the parties stating that filing fees of $1,750 were due upon receipt. Once the fees were received, JAMS would formally commence the matter and proceed with the arbitrator selection process. The employer paid the filing fees on May 13, 2022.

The employee filed a motion in the trial court to withdraw from arbitration pursuant to Section 1281.97. The employer opposed the motion on several grounds, including that the FAA and the Federal Rules of Civil Procedure applied to the arbitration, rather than California law.

After a hearing, the trial court found that the employer had paid the required arbitration fees late and therefore breached the arbitration agreement, as provided in Section 1281.97, and granted the employee’s motion to withdraw from arbitration. The employer appealed.

California Law Governing a Failure to Pay Arbitration Fees

Even prior to enactment of Section 1281.97, an employee could avoid enforcement of an arbitration agreement by showing that the employer’s failure to perform an obligation under the contract was a material breach of the agreement. Unless a contract states that time is of the essence, a payment made within a reasonable time after the specified due date will usually constitute substantial compliance, the court noted.

In 2019, the California Legislature added Section 1281.97 to California law. Section 1281.97 does not require that the arbitrator make an initial finding of breach, default or waiver. The statute defines a material breach to be the failure to pay anything less than the full amount due by the expiration of the statutory grace period. There are no exceptions to Section 1281.97 for substantial compliance or lack of prejudice.

Pre-emption

Federal pre-emption is the invalidation of a state law that conflicts with federal law. The employer contended that Section 1281.97 did not apply in this case because it was pre-empted by the FAA. The employee claimed that California law applied, including Section 1281.97. The appeals court sided with the employer, concluding that the FAA applied and reversing the trial court order allowing the employee to bypass arbitration and proceed to court.

The court first noted that parties can avoid pre-emption by expressly agreeing to apply state law to their agreements. If parties expressly agree to apply California law, the FAA will not pre-empt state arbitration laws. In other words, the court said, if the parties have agreed to apply Section 1281.97, no discussion of pre-emption is required.

Similarly, if parties agree to apply the FAA’s procedural provisions, rather than the procedures of the California Arbitration Act (CAA), then the state arbitration procedures do not apply and there is no pre-emption issue.

The court then noted that the arbitration agreement in this case plainly states “this agreement is governed by the FAA.”

There is no provision explicitly referring to California law in the agreement, and, therefore, the procedures of the CAA, including Section 1281.97 do not apply, the court said.

However, the court continued, even if it were to conclude that that Section 1281.97 applied, it would still reverse the order in this case. When an agreement falls within the scope of the FAA and the parties have not expressly elected California law, the FAA pre-empts the portion of Section 1281.97 that requires findings of material breach and a waiver of the right to arbitrate.

Whether a state statute is pre-empted by the FAA depends on whether the statute conflicts with or obstructs the purpose of the FAA, the court explained. State laws that impose requirements that discourage formation or enforcement of arbitration agreements are pre-empted.

The court observed that Section 1281.97 mandates findings of material breach and waiver for late payment that do not apply generally to all contracts or even to all arbitrations. Under California contract law, defenses to enforcement of a contract are generally questions for the trier of fact and subject to doctrines such as substantial compliance, but Section 1281.97 imposes a stricter requirement, mandating a finding of material breach and waiver in employment arbitration contracts and making it harder to enforce arbitration agreements in those matters.

The court concluded that unless the parties have expressly selected California’s arbitration provisions to apply to their agreement, the FAA pre-empts the portion of Section 1281.97 that dictates findings of material breach and waiver.

Hernandez v. Sohnen Enterprises Inc., Calif. Ct. App., No. B323303 (May 22, 2024).

Joanne Deschenaux, J.D., is a freelance writer in Annapolis, Md.